Sunday, January 03, 2010

Growing by your own bootstraps

Let's say we own shares in MREIT with a BVPS of $10.00 per share, and in which each $1 of book equity when fully leveraged/invested is good for generating $0.10/year in FAD (funds available for distribution).

Now imagine that the REIT is trading at $12/sh and does a secondary public offering which causes fully diluted BVPS to become $10.50/sh for all shareholders. The REIT's earnings power post-money has just grown by 5%; for both existing and new shareholders. Assuming a constant price to book multiple, the market value of the company increases each time it raises capital.

This ability to grow by your own bootstraps has certain limitations:

  1. The stock must be trading sufficiently above BVPS that new capital raises will be accretive to earnings. Usually this means at least a 10% premium to book.
  2. Management must be able to invest the new capital with enough speed to meet the now larger dividend obligation that results from having more shares outstanding.

The speed at which new capital can be deployed, depends on the amount of thought and work needed to evaluate and acquire new assets. Generally buying securities takes less time than buying more customized assets such as self originated loans or equity investments. This really shows with the Agency RMBS REITS (E.g NLY et al) for whom the Agency RMBS+repo market can satisfy any amount of new investment.

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